What Are Stocks and How Are They Valued?

If you’re new to investing, or even just interested in growing your money over time, stocks are a big part of the equation. But what exactly are stocks and how do they work? And what’s all this talk about “fair value” that financial professionals throw around? This article will help you demystify the stock market jargon and understand the fundamentals of how a stock’s value is determined.

A stock is a security that represents fractional ownership in a publicly-listed corporation or company. Investors purchase shares of a company to profit from the growth of the stock, which can be done either by increasing its price or by earning dividends. Generally, the more established the company is, the lower the risk of losing money, although even large companies can fail, which can wipe out all your investment.

The process of issuing a stock involves a public company seeking investors to buy its shares on the open market. The process is usually overseen by a securities and exchange commission (SEC). Companies sell their stock in order to raise capital for things like paying off debt, launching new products or expanding operations, according to the U.S. Securities and Exchange Commission. As a shareholder, you can make money when the stock price rises, earn dividends if a company distributes earnings and vote at shareholders’ meetings.

A company can issue different classes of stock, each with different voting rights or other special features. For example, Alphabet — the holding company that owns Google and other brands — has three classes of stock. Class A gets one vote per share; class B has 10 votes per share; and class C doesn’t have any voting rights at all. These additional classes exist to help company founders or executives retain a degree of control over the company.

Stocks are often valued against the performance of an index such as the S&P 500 or Wilshire 5000. These are essentially broad-brush baskets of the most prominent stocks in the US, weighted by their market caps – the total value of a company’s shares. But figuring out a stock’s fair value can be complex, and it can depend on many factors beyond those included in the index.

For example, the quality of a company’s management team can have a huge impact on its fair value, as can industry and market conditions. In addition, technological advances and innovative breakthroughs can boost a company’s fair value as well. These innovations can come from a variety of sources, including start-ups, venture capital firms or research and development departments of established companies. In this case, the company would likely receive higher valuations than a competitor that hasn’t made any such advancements. Ultimately, the best way to determine a company’s fair value is to compare it with similar companies in its sector. Using this information, you can then decide whether it’s overpriced or a good deal. This is also the key to generating a positive return on your investment over the long term.